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Wednesday, February 20, 2008

Ilargi: The bond insurers themselves may not want to reveal their true losses, but how much longer can regulators like Spitzer and Dinallo do the same? Ackman calls them all out, and he has become a voice and a force to reckon with.

Activist investor William Ackman met Tuesday with New York State Insurance Commissioner Eric Dinallo to unveil yet another plan to bailout troubled bond insurance companies as banks and regulators continue to squabble over a way to save these floundering businesses from rating agency downgrades, CNBC has learned.

The plan by Ackman, who has been shorting shares of bond insurer MBIA, is a surprise since Ackman has released data he says shows that the bond insurers face at least $12 billion in liabilities each because of their decision to underwrite risky structured finance securities such as collateralized debt obligations, or CDOs, held by Wall Street firms and major banks.

The bond insurers say that their problem is far smaller than what Ackman has said. Still, the problem is big enough for at least one insurer, Financial Guaranty Insurance Corp., to say it will split its business to protect municipal-bond policy holders from being infected by far riskier CDOs, while the other major troubled insurers, Ambac and MBIA are considering similar moves.

Ackman’s plan isn’t so much a bailout as it is an attempt to call the bond insurers bluff about the potential size of their losses. "Ackman's really calling their bluff here," said Joseph Mason, professor of finance at Drexel University. "They just want to continue business as usual."

Under the plan being discussed by Dinallo and the insurers, the companies would split their businesses into two separate units, one that insures municipal bonds and the other that insures CDOs. Profits from the muni insurance will flow to the holding company, thus securing the insurers’ AAA rating. These profits would be diverted away from the CDO portfolio, meaning that the banks that hold these securities would have to begin massive writedowns as their CDO lose their triple-A rating.

Ackman's plan treats all the policyholders equally, according to people briefed on the measure. The insurers would still be divided into two separate units so the muni-bond portfolio can maintain a triple-A rating, but any profits from the muni insurance - one of the most stable and profitable on Wall Street since municipalities rarely default on their debt - would flow to support the CDO portfolio.

Ackman has told New York State regulators, and officials from the US Treasury Department monitoring the situation that if the bond insurers are right, and their potential losses from CDOs are manageable, they will begin making money fairly quickly, while supporting the insurance policies not just of municipalities but also of banks holding insured CDOs.

But if they're wrong and he's accurate and the losses are much greater, the markets should determine the bond insurers' fate as they would likely loose their triple-A rating and would no longer be able to write new insurance business.

We are headed for the Great Deflation – a period spanning a decade or more of very slow growth, rising unemployment, flat or falling real wages, fewer employer-provided benefits and increasing pressures on government finances. People borrowed money because they had to. Income growth simply did not keep pace with prices in housing, health care, transportation, energy and food. Much of the debt that families borrowed to finance their consumption came from overseas, which contributed to record high trade deficits.

And, the situation is further exacerbated by the fact that productivity growth, the battery in the Energizer Bunny, seems to be running out of juice, since businesses haven't invested enough in the face of lower demand for their products. The chickens are coming home to roost. Families either default or repay their debt. Either way, they consume less and economic growth slows. This slowdown can last for some time, just like the run-up in debt did.

At the same time, the structural weaknesses will exacerbate the long-term outlook. Specifically, businesses will have no incentive to invest more if their customers are paying back debt instead of going shopping, thus contributing to less productivity growth. And government revenues will shrink because economic activity is slowing, resulting in less spending, including on education, thereby contributing to the slowdown in innovation. Yet, without faster productivity growth, our competitiveness will suffer and it will be harder to reduce our trade deficit through export growth.

Unlike a recession, these structural weaknesses do not force politicians to act. In a recession, unemployment jumps quickly and businesses go out of business in rapid succession. This generally gets policymakers' attention. There never comes such a point in time, when policymakers' attention is forced to focus on the economy, however, when economic growth slows gradually and stays low for some time.

Step 1 is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 per cent from their peak, which would wipe out between $4,000bn and $6,000bn in household wealth. Ten million households will end up with negative equity and so with a huge incentive to put the house keys in the post and depart for greener fields. Many more home-builders will be bankrupted.Step 2 would be further losses, beyond the $250bn-$300bn now estimated, for subprime mortgages. About 60 per cent of all mortgage origination between 2005 and 2007 had "reckless or toxic features", argues Prof Roubini. Goldman Sachs estimates mortgage losses at $400bn. But if home prices fell by more than 20 per cent, losses would be bigger. That would further impair the banks' ability to offer credit.Step 3 would be big losses on unsecured consumer debt: credit cards, auto loans, student loans and so forth. The "credit crunch" would then spread from mortgages to a wide range of consumer credit.Step 4 would be the downgrading of the monoline insurers, which do not deserve the AAA rating on which their business depends. A further $150bn writedown of asset-backed securities would then ensue.Step 5 would be the meltdown of the commercial property market, while Step 6 would be bankruptcy of a large regional or national bank.Step 7 would be big losses on reckless leveraged buy-outs. Hundreds of billions of dollars of such loans are now stuck on the balance sheets of financial institutions.Step 8 would be a wave of corporate defaults. On average, US companies are in decent shape, but a "fat tail" of companies has low profitability and heavy debt. Such defaults would spread losses in "credit default swaps", which insure such debt. The losses could be $250bn. Some insurers might go bankrupt.Step 9 would be a meltdown in the "shadow financial system". Dealing with the distress of hedge funds, special investment vehicles and so forth will be made more difficult by the fact that they have no direct access to lending from central banks.Step 10 would be a further collapse in stock prices. Failures of hedge funds, margin calls and shorting could lead to cascading falls in prices.Step 11 would be a drying-up of liquidity in a range of financial markets, including interbank and money markets. Behind this would be a jump in concerns about solvency.Step 12 would be "a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices".

Can the Fed head this danger off? In a subsequent piece, Prof Roubini gives eight reasons why it cannot***. (He really loves lists!) These are, in brief: US monetary easing is constrained by risks to the dollar and inflation; aggressive easing deals only with illiquidity, not insolvency; the monoline insurers will lose their credit ratings, with dire consequences; overall losses will be too large for sovereign wealth funds to deal with; public intervention is too small to stabilise housing losses; the Fed cannot address the problems of the shadow financial system; regulators cannot find a good middle way between transparency over losses and regulatory forbearance, both of which are needed; and, finally, the transactions-oriented financial system is itself in deep crisis.

Ilargi: John Authers, in the Financial Times, raises an issue that in all its simpleness, and perhaps because of it, has so far been mostly overlooked. Equity markets look, at least at the surface, like they're doing quite well, while credit markets are on life support with the last rites about to be read. Where does this difference come from? If it's so hard to get credit, what buys the equities? I think the answer is equally simple: vast amounts of existing credit are being moved around the markets. Yesterday I posted a statement by Lee Adler about how such a move is underway from ABCP to money market funds. We are talking huge amounts of money here. The problem with all this, which will soon reveal itself, is that much of this 'existing credit' is about to implode: as long as you don't tell the truth about your losses, you can look like quite a rich man, no matter how broke you are.

The equity market seems to think that it can safely ignore the credit markets. If you believe the credit market, things have worsened sharply in the past few weeks. With spreads widening significantly, recession is a certainty in the US and Europe. If you believe the equity market, there are grounds for optimism. Stocks are still above the low they hit in January, before the Federal Reserve made its emergency rate cut – betting that this huge monetary stimulus would ensure that any recession is shallow.

The decoupling of credit and equity is also visible at the level of individual stocks. Ian Scott, equity strategist at Lehman Brothers in London, points out that the stock prices of companies with relatively poor credit quality have fallen faster than the market as a whole over the past six months – in line with the deterioration of the credit market as a whole.But in the past few weeks, as credit spreads have widened, the shares of those companies the credit market sees as most risky have rallied, and outperformed the rest of the market. Equity investors are making a bet that the credit market has got it wrong.

The credit market may be at levels that cannot be justified by the fundamental outlook for defaults: its investors have difficulty raising liquidity; many need to clean their balance sheets; there are unprecedented worries over various structured credit products, many of which did not exist during the last downturn in the credit cycle; and the problems of the monoline bond insurers create further uncertainty.

Alternatively, the stocks rally may have been driven by “short covering” as traders stopped betting that stocks would go down. Or the equity market is in denial about the acute problems in the credit market. Whatever the explanation, the disconnection is unlikely to persist for long.

Ever since Eliot Spitzer threatened the troubled monoline insurers that he'd break them up, everyone has acted as if that's a viable option. But this talk of a split reminds me of movies about Hollywood, where someone buttonholes a producer with his pet idea: "See, it's like Flashdance, except you reverse it: the girl is a Hispanic ballerina who started stripping to pay her student loans...."

Like the film proposal, the break up notion is still at the high concept stage, little more than, "let's separate the muni operations from the rest." And while admittedly Ambac has had only the long weekend to work on its plan, the update as of Monday evening via the Wall Street Journal suggested that the group is flailing around.

Ambac Financial Group Inc. is discussing a plan to raise at least $2 billion in much-needed capital to help the world's second-biggest bond insurer retain its top-notch credit rating, according to people familiar with the matter.

The extra cash, to be raised by selling shares to existing investors at a discount, would likely be a prelude to a trickier and lengthier move: splitting itself into two businesses.

Remember, Ambac was trying, like all the other bond guarantors, to raise money before Spitzer delivered his ultimatum. That went nowhere. But we are now back to Plan A, except with the break up idea added. But does that make investing any more attractive?

The answer is no. Before, you had a situation that was either going to end badly, if you believed Bill Ackman and the shorts, or was misunderstood and therefore perhaps a buy, if you believed the insurers. (Aside: my sense is no one has lifted the kimono enough for anyone to get a reading as to the exposures, which does not encourage investors). In other words, you had a high degree of uncertainty (how bad will the mortgage business get? How much capital might be needed over time to keep an AAA rating?), but it could be analyzed.

Now, Ambac is seeking to raise money. It hopes to split up, but gee, we aren't certain we can do that, and even if we can, we aren't exactly sure yet how this will work. Is any one with any sense going to invest in a proposition like that? You have absolutely no idea what you are getting into. This whole discussion of a breakup plan has increased uncertainty enormously and raised the specter of litigation risk. Those are not exactly comforting to investors.

Why this volte face? Remember, the earlier plan, as of Friday, appeared to be "split 'em up, we can raise capital for the good muni business, the hell with the rest." Assuming you could segregate the muni operations, this plan might work. If MBIA could raise over a billion (albeit with a Warburg Pincus backstop), Ambac and its buddies might be able to stump up enough to pay the steep reinsurance rates that Buffett is demanding. It appears they have discovered that they lack a legal basis for preferring the muni policyholders over the others, and even if they try not to prefer one group over another, it is going to be well nigh impossible to come up with a formula that won't be contested

Ilargi: I'm not interested in the political gain that parties seek by accusing each other. Two things do make me curious: First: the role of Granite, an offshore fund set up by Northern Rock, and now apparently exempt from the nationalization efforts (which are far from done). And second, the line below: "Fears grew that other banks may be in trouble after the Treasury unveiled plans to allow the Government to take any financial institution into public ownership over the next year in a move described as "draconian".". The British media should by now be all over that issue (but they are not): what if more banks fail? The government has already takes steps in preparation.

The cost of the Northern Rock crisis has reached the equivalent of £3,500 for every taxpayer as experts warned that the nationalisation rescue of the bank was bound to fail. Taxpayers' exposure to the beleaguered bank has doubled since the beginning of the year and now stands at about £110 billion - more than the annual budget of the NHS and the equivalent of 27p on the basic rate of income tax.

Ron Sandler, Northern Rock's new chairman, has been forced to admit that the bank may remain in public hands for "years" - undermining claims by Gordon Brown that the nationalisation was only temporary. Plans are being drawn up to lay off thousands of bank workers, reduce the savings rates of a million customers and sell branches in an attempt to persuade the European Union to sanction the biggest nationalisation in Britain's history.

As the full scale of taxpayer liabilities became clear it emerged that more than 800,000 people with Northern Rock mortgages are now effectively in debt to the Government. There were growing concerns over the Government's ability to run the bank competitively, with senior City figures claiming that the business would end up being killed off.

The Tory leader's intervention came as:• Northern Rock's 180,000 shareholders began preparing legal action against the Government amid fears that they will be left with virtually nothing under the nationalisation.• Fears grew that other banks may be in trouble after the Treasury unveiled plans to allow the Government to take any financial institution into public ownership over the next year in a move described as "draconian".• The Conservatives pledged to vote against the nationalisation plans in Parliament, claiming that they represented a return to the "dark days of the 1970s".• Ministers came under pressure to release the advice they received from Goldman Sachs over the future of Northern Rock after it was alleged that critical decisions were delayed in September as Mr Brown dithered over whether to call an election.

Gordon Brown has been accused of failing to answer questions on Northern Rock, including why its most profitable part will not be nationalised. Tory leader David Cameron said Mr Brown's lack of openness would "make Fidel Castro proud". And the Lib Dems threatened to derail the bill nationalising Northern Rock unless the government explained why key assets were staying in private hands.

Mr Brown insisted the government was acting in taxpayers' interests. The government is rushing through emergency legislation to nationalise Northern Rock after efforts to find a private buyer failed. But opposition MPs are concerned it has not done enough to protect taxpayers if the bank runs into further trouble.

There is particular concern about the role of Granite - a Jersey-based trust set up by Northern Rock in 1999 to package up and sell on its best mortgages to investors - which owns about half of the bank's assets. Granite contains about £45bn of Northern Rock's most profitable mortgages but it will not be nationalised - leading opposition MPs to claim taxpayers will be left with the "rubbish" in the bank's mortgage book.

Mr Cameron and Lib Dem leader Nick Clegg both raised the issue at prime minister's questions in the Commons. Mr Clegg said the way the nationalisation had been handled was "jeopardising the interests of the British taxpayers". Mr Brown insisted "stability" was the government's "watchword" - and Granite would "not affect the sale of Northern Rock to a private buyer". Responding to questions from Mr Cameron, Mr Brown said it was necessary to exempt Northern Rock from freedom of information laws because of commercial confidentiality.

He claimed the Conservatives had been through six different policies on Northern Rock, with their latest set of proposals amounting to "fire sale" of its assets. Mr Cameron described the prime minister's answers as "feeble" as several other publicly-owned companies were subject to FoI laws. He said Mr Brown had failed to say what the total liability to the taxpayer would be over Northern Rock, how long the public would own it and why half of its mortgages would be left in private hands.

Ilargi: Think there's any chance we'll get Canadians to pay attention now, before there's nothing left that they can do?

As the credit crisis continues to grip the global financial sector, most Canadian banks are in embarrassingly good shape. Want to buy a U.K. bank for six times profit and a 6% dividend yield? Or would you rather pay 12 times for a Canadian bank with a 4.5% dividend?

Still, Canadian investors should remember two things: Bad news from our banks tends to come out gradually. Second, the good fortunes of Canadian banks are due to a prolonged economic boom that won't last forever. From the lofty heights at which Canadian banks are perched, the fall could feel steeper than it actually is.

Consider yesterday's news out of Bank of Montreal. The headline: "$490-million in charges before tax." That includes a $160-million hit for BMO transactions hedged with troubled monoline insurer ACA Financial Guaranty and $330-million of assorted other credit crunch-related booby traps. More fallout is likely to come.

Within the fantasy realm in which Canadian banks operate, however, a small write-down tucked in at the bottom of the charges should cause just as much concern: a $60-million pre-tax hit to reflect "an increase to the general allowance for credit losses to reflect portfolio growth and risk migration."

This marks the second quarter in a row in which BMO has increased its kitty for expected loan losses. If BMO's financial wizards are right, the canary in the coal mine of the Canadian economy has just keeled over. For five years, loan-loss provisions have declined among Canadian banks; at BMO, they fell to $888-million in the third quarter of 2007 from $1.18-billion at the end of 2002, reflecting improving credit quality. Suddenly, BMO is one-third of the way back up to where it was five years ago.

Add to that recent comments by Ed Clark, chief executive of Toronto-Dominion Bank, that a U.S. slowdown would hit Canada, and it's time to ask what other bad news is coming from the core operations of the big banks. "This is the start of the momentum for material increases in provisions for credit losses as the Canadian banks face a difficult credit environment in 2008 and 2009," said John Aiken, Dundee Capital Markets analyst.

Loan-loss provisions among Canadian banks, which have averaged a modest 0.4% over the past dozen years, are now just under 0.3% and, by Mr. Aiken's estimate, heading back to the average. That's hardly earth-shattering, but we're talking Canada, where fat profits, 20% returns on equity (ROE) and high valuations are the norm. If the loan-loss ratio rises by 10 basis points, it will reduce Big Bank earnings this year by 4%, Mr. Aiken estimates.

Analysts, on average, estimate profits will grow by 5%. "This change could wipe out all growth, with obviously negative impact on valuations." Mr. Aiken said. ROE would likely fall by 300 to 400 basis points. That won't exactly prompt Ottawa to nationalize the banks, as the U.K. is doing with Northern Rock PLC. But it could lead to a 20% drop in price-to-book multiples, and corresponding stock prices, for Canadian banks.

Ilargi: In the US, SIV’s were declared dead 6 months ago. Not so in Canada. That makes me think of Mark Twain: "If the world were coming to an end, I'd go to Cinncinnati, because everything happens there ten years later."

Bank of Montreal, Canada's fourth- largest lender, will provide as much as $12.7 billion of financing to help its two structured investment vehicles avoid being forced into a fire sale of assets. The Toronto-based bank expects about half of the "backstop"to be drawn by its Links Finance and Parkland Finance SIVs, according to a statement today. The funding includes payments announced last year; Bank of Montreal said in November it would provide no more than C$1.6 billion ($1.59 billion) for its SIVs.

"Six billion dollars remains an extremely large exposure for BMO, even if the assets are of relatively high quality,"John Aiken, a Toronto-based analyst at Dundee Securities Corp. wrote in a note to clients after downgraded the bank's stock to "market underperform"from "market neutral.""The SIV commitment will remain an overhang on BMO's valuation."Banks led by HSBC Holdings Plc and Citigroup Inc. have stepped in to support their SIVs with more than $140 billion of assets since the collapse of the U.S. subprime mortgage market caused the prices of the funds' assets to decline last year. SIVs, which use short-term borrowing to invest in longer-dated assets, cut their holdings by more than $100 billion from a peak of $400 billion last year, according to Moody's Investors Service.

Bank of Montreal will "provide the SIVs with supplemental funding and permit the SIVs to continue the strategy of selling assets in an orderly manner,"the statement said. It won't have a "material adverse impact"on the bank's finances.

Bank of Montreal (BMO) has been forced to write down around $323.9 million for the first quarter of 2008 and will hope its replacement chief risk officer will give it a better future after a catalogue of woes. Because of the hit, BMO has taken a charge of nearly 70 cents per share for the first quarter, which almost halves the per share earnings predicted by analysts.

But this quarter's results come as no major surprise given the fact that costs over the past year were in excess of $1 billion, with debt transactions with bond insurer ACA Capital Holdings the main source of the bank's troubles. BMO is Canada's fourth biggest bank and only Canadian Imperial Bank of Commerce has been more badly affected by the sub-prime crisis.

"While the charges individually are not overly material, we are disappointed by the breadth,'' Dundee Securities analyst John Aiken told Bloomberg. ''Investors may begin to question when the litany of charges from BMO, typically thought of as a steady bank, will come to an end.'' Stock in the bank has dropped a quarter of its value over the past 12 months and last year it sustained the biggest trading loss ever incurred by a Canadian bank.

Ilargi: A story that will become all too familiar soon. Municipalities face less tax revenue due to lower property prices, increasing problems with bond issuance, wrong investments and the list goes on. People working for cities, direct or indirect, will laid off in large numbers.

The city of Vallejo is on the brink of becoming the first California city ever to declare bankruptcy, City Council members said Tuesday. Vallejo may run out of cash as early as March, council member Stephanie Gomes said. "Not only that, but now we have 20 police and fire employees retiring because they are afraid of not getting their payouts," Gomes said. "That means we have another few million dollars in payouts that we had not expected. So the situation is quite dire."

Gomes said the situation has been building for more than a decade. "This has been happening for quite a while. For 15 years the city council has been putting Band-Aids on the problem. (It has been) extending contracts and deferring payments for public safety to the next years as a way of balancing the current budget." Public safety contracts for police and fire services make up 80 percent of the city's general fund.

"We've been spending more than we've been making for 20 years and it's time to pay the piper," Gomes said. Newly elected Mayor Osby Davis is downplaying the possibility, NBC11's Jodi Hernandez reported. "I like to look on the positive side," Davis said. "I'm confident we're going to be able to work this out without having to file bankruptcy. It's not an alternative we want the public to believe we're moving toward with any intention."

Council members Joanne Shivley and Gomes have announced they will host a community town hall meeting this Thursday to discuss bankruptcy.

It turns out that massive interest rate spikes aren't the problem -- many borrowers couldn't afford these mortgages even at the low, introductory interest rates.

For months, we've fretted about the Armageddon that will hit when subprime adjustable rate mortgages start resetting to much higher interest rates. What's happening is even worse: Many of these loans are defaulting well before their rates increase. Defaults for subprime loans issued in 2007 - none of which have reset yet - hit 11.2 percent in November. That represents perhaps 300,000 households, and is twice the default rate that 2006 loans had 10 months after being issued, according to Friedman, Billings Ramsey analyst Michael Youngblood.

Defaults are spiking well before resets come into play thanks to the lax lending environment of the past few years. Many borrowers were approved for mortgages that they had little chance of affording, even at the low-interest teaser rates . "I was rather shocked by the characteristics of the 2007 loans," said Youngblood.

Hybrid ARMs start with very affordable fixed-rate terms of two or three years. After that, rates can jump three percentage points or more, and then re-adjust even higher every six months to a year. On a $200,000 mortgage, a reset could add nearly $400 to the monthly mortgage payment. Originally, concerns about these loans focused on the fact that that most homeowners wouldn't survive such pricey resets. In late 2006, the Center for Responsible Lending (CRL), predicted that 2.2 million subprime ARM borrowers would lose their homes in the following two years due to reset shock.

But these mortgages were doomed from the start. For instance, in both 2006 and 2007, well over 40 percent of subprime borrowers were awarded mortgages with either little or no documentation of their ability to pay. With these so-called "liar loans," borrowers did not have to show proof of either earnings or assets.

And even when borrowers did go on the record about their earning power, it didn't bode well. Both 2006 and 2007 saw a large proportion of loans with high debt-to-income ratios (DTI), which indicates the percentage of gross income required to pay debt. In 2007 subprime originations, the DTI hit 42.1 percent, up from 41.1 percent in 2006. Borrowers were simply taking on more debt that they could afford.

Ilargi: Lately, not a day goes by without more stories of deepening distress in Germany. Remember, this is the world's 3th-4th economy, and the biggest exporter of them all.

A mysterious supergrass, German spies, a €4m (£3m) CD and the Alpine principality of Liechtenstein. These are the ingredients for a tax dodge mystery that some are describing as Germany's biggest financial scandal since the Second World War.

Police, tax investigators and state prosecutors began searching hundreds of homes and offices throughout Germany yesterday, swooping on addresses in Munich, Hamburg, Stuttgart, Ulm and Frankfurt in a bid to unravel the fraud and root out an estimated 1,000 tax evaders suspected of illegally transferring up to €4bn to secret accounts in Liechtenstein.

The first evidence of a scandal emerged at the end of last week following the sudden resignation of the Deutche Post chief executive, Klaus Zumwinkel, over claims that he had evaded €1m-worth of tax over 20 years, allegedly depositing the cash in a Liechtenstein account. The scandal exploded over the weekend, with officials at Germany's equivalent of MI5, the Bundesnachrichtendienst (BND), disclosing that they had gleaned information about a more widespread fraud from a CD containing records from Liechtenstein's LGT bank that they had purchased from an unidentified informant.

The CD was said to contain detailed evidence about secret accounts held by hundreds of German clients. "We consider that the €4m we paid out for the CD was a good investment on behalf of the German tax payer," a BND spokesman was reported as saying yesterday. A spokesman for the state prosecutor's office in the west German city of Bochum, which began the hunt for tax evaders on the basis of the BND's information, said that the CD had effectively "cracked the entire bank".

But yesterday Bernd Bienossek, the chief Bochum state prosecutor, declined to comment on the scale of the hunt for tax evaders, many of whom have been described as "prominent". "We're not going to say much. We don't want to expose people unnecessarily," he said. But police in at least five German cities admitted that raids had taken place and that several individuals who were suspected of tax evasion had already turned themselves in to the relevant authorities. Police said the hunt was likely to continue for weeks.

Schmidt will step down March 1, Munich-based BayernLB said today in a statement. He will be replaced by management board member Michael Kemmer, who was appointed by the state-owned bank's administrative board today, the company said.

BayernLB, which invested about 4 billion euros in subprime- related investments, last week joined German public lenders including WestLB AG and Landesbank Baden-Wuerttemberg that have announced billions in writedowns. The worst U.S. housing slump in a quarter-century has forced the world's biggest banks to book more than $145 billion in writedowns and loan losses.

"This highlights again that the Landesbank sector has been hit pretty hard by the crisis,'' said Simon Adamson, a financial services analyst at CreditSights Inc. in London. "Germany's state- owned banks invested a lot in higher-yielding structured products because their core profitability is very weak and now they're suffering."Schmidt "embarrassed'' the lender's administrative board and its deputy chairman Erwin Huber, finance minister of the German state of Bavaria, when he sought to publish figures on BayernLB's subprime losses without first informing them, the German newspaper Sueddeutsche Zeitung reported on Feb. 15.

Ilargi: Misleading numbers?! Wall Street is not "at risk" for $30B in the bond insurer crisis, it will have to come up with that amount just to cover the losses thus far.

All told, 20 banks and securities firms may be forced to ramp up reserves in worst-case scenario.If the bond insurance crisis worsens, banks and securities firms may have to sock away billions of dollars more in reserves, Moody's Investor Services said in a report published Tuesday. Right now, the credit rating agency estimates that about 20 different financial institutions have about $120 billion worth of credit default swaps on asset-backed collateralized debt obligations guaranteed with different bond insurers.

The report said that banks may have to ante up as much as $30 billion in reserves to offset worsening conditions related to the bond insurance industry. To date, major financial firms have endured losses totaling more than $100 billion as a result of bad bets on mortgage securities and some analysts are warning that that number could grow.

Some fear that if bond insurers like Ambac (ABK) and MBIA (MBI) were stripped of their 'AAA' rating, that could spark the next wave of writedowns at the nation's largest financial firms.

A homeless woman earning $10 an hour was recently approved for a $470,000 adjustable rate mortgage. The New York State Commission of Investigation is analyzing this case and others in hearings on mortgage fraud and subprime lending.

The subprime meltdown has put a spotlight on predatory lending practices. Government agencies and commissions across the nation are investigating an increasing number of mortgage fraud complaints.

One of the most interesting stories came from a hearing held on February 13 by the New York State Commission of Investigation. Testimony was given by Suzette Francis who claims she was a victim of mortgage fraud.

In 2006, Francis was living in a homeless shelter in Queens, New York after losing her job. She found a new job as a security guard and approached the principal of her child's school to ask about getting an apartment.

The principal--who was also in the real estate biz--told her that she did not know of any available apartments but that she did know of a house for sale. She then helped Francis, who was earning a modest $10 an hour at the time, get approved for a $470,000 adjustable rate mortgage through a 'special Fannie Mae program' in October of 2007.

The woman who set everything up fudged the mortgage application by inventing false income and claiming that Francis worked for the school. The fraud was necessary because Francis could not reasonably make the monthly mortgage payment of $4,517 on what she actually earned.

Since living in the house, she has not made any mortgage payments. The home is now in foreclosure and Francis has learned that she also owns a second home that was also purchased with fraudulent documents. Francis admits that she does remember being asked to sign additional paperwork at one point but that she was told it was for the first house.

No charges have been filed yet against the woman who supposedly initiated the fraud and Francis is still living in the foreclosed home. The New York State Commission of Investigation, which is a bipartisan independent body, is investigating this case and others in a series of hearings. The investigations are a direct result of increased complaints, according to commission chairman Alfred Lerner.

Regulators are trying to punish Wall Street for mortgage finance practices that expanded home ownership and spread risk among a host of new players — but also may have duped borrowers and investors who supplied cash to fuel a housing boom that's turned bust.

A handful of state securities regulators and a couple foreclosure-blighted cities have fired the opening shots with lawsuits trying to prove that investment banks and big lenders are guilty of more than just bad business decisions and failing to foresee looming mortgage troubles. Some regulators say greed and fraud underlie much of the subprime mortgage mess that has spread across the broader housing market, triggering a spike in foreclosures.

Aside from the civil cases, the FBI is looking at possible criminal action, focusing on what Wall Street firms knew about the risks of mortgage securities backed by subprime loans, and whether they hid risks from investors. Observers don't expect the financial penalties that regulators extract in the civil cases to be massive. But the cases could turn up evidence that forces Wall Street to defend itself amid growing talk of government help to ease subprime-related financial strains on bond insurers. Revelations of bad behavior turned up by the government also could spur private investors to file even more lawsuits than the hundreds they've already brought to recover losses.

"This could get a lot nastier, for many reasons," said John Akula, a business law lecturer at the Massachusetts Institute of Technology's Sloan School of Management. "Prolonged close scrutiny often turns up all kinds of dubious practices that in normal times are under the radar. "If the government sponsors any kind of bailout with public funds, this may be coupled with an aggressive prosecutorial agenda in support of efforts to get private parties to kick in." Although the foreclosure-blighted cities of Cleveland and Baltimore have sued seeking to recover damages from mortgage lenders, most of the cases filed so far are from regulators alleging violations of state securities laws.

Attorneys general in New York and Ohio are targeting alleged systematic inflation of home appraisals by major lenders and appraisal firms. Litigation in Massachusetts and other states seeks to demonstrate that investment banks failed to disclose risks to investors who bought mortgage-related securities and weren't up front about conflicts of interest across their far-flung financial operations, including trading of subprime investments.

"Over the years, the relationship between lender and borrower and a particular piece of property has been severed," said Massachusetts Secretary of State William Galvin. "It's clear that it's become a runaway train." Gone are the days when most borrowers simply got loans from the neighborhood bank, which used to hold the bulk of mortgage risk. Now that risk is spread further — mortgages are bundled together and sold to investors. Behind the scenes, credit-rating agencies offer advice on whether the investments are secure. Until recently, cash from Wall Street banks and investors extended growing amounts of credit to low- and middle-income Americans enticed to enter a market when home prices appeared headed nowhere but up.

Lenders wrote $625 billion in subprime mortgages in 2005, nearly four times the total in 2001. The boom brought in big fees to mortgage brokers, lenders, banks and ratings agencies. But now that prices are dropping, those players are hurting. Global banks have ousted executives and have written off nearly $150 billion since mortgage securities began collapsing last summer. Given the losses, "It's doubtful some of these entities will repeat their performance," Galvin said. "But I think there needs to be an understanding of how we got where we are, whether that is through regulatory action, or through Congress."

State regulators and cities that have filed cases or disclosed investigations targeting Wall Street firms' roles in the subprime mortgage market:

New York Attorney General Andrew Cuomo has accused a major real estate appraisal company of colluding with Washington Mutual Inc., the nation's largest savings and loan company, to inflate the values of homes nationwide, contributing to the subprime troubles. Cuomo also has issued subpoenas to Fannie Mae and Freddie Mac, seeking information about potential conflicts involving loans the government-sponsored lenders bought from banks. And Cuomo and Connecticut Attorney General Richard Blumenthal are investigating whether banks properly disclosed risks of mortgages that were bundled into securities sold to investors.

Ohio Attorney General Marc Dann has accused 10 mortgage lenders and appraisal companies of pressuring appraisers to inflate home values. Dann also has sued Freddie Mac, accusing it of defrauding Ohio's public employee pension fund by investing in subprime home loans. Dann also is considering a broader case against Wall Street banks, lawyers and bond-rating agencies.

Massachusetts' top securities regulator, Secretary of State William Galvin, has accused a unit of investment bank Bear Stearns Cos. of failing to disclose to investors a conflict of interest in its trading with two Bear Stearns-managed hedge funds. The funds collapsed after making bad bets in subprime-linked investments. And last month, Galvin subpoenaed municipal bond insurers MBIA and Ambac, seeking information on how much the firms disclosed to cities and towns about their exposure to mortgage-related investments. On Feb. 1, Galvin accused Merrill Lynch of fraud and misrepresentation, a day after the firm agreed to reimburse the city of Springfield, Mass., $13.9 million in a dispute over a subprime-related investment that soured. Galvin alleges Merrill Lynch made unsuitably risky investments on behalf of Springfield without permission.

Attorneys general in Illinois and Florida are investigating mortgage lender Countrywide.

The city of Cleveland in January sued 21 banks and claimed their subprime lending practices have left behind abandoned homes, creating a public nuisance that hurts property values and tax collections. Two days earlier, Baltimore sued Wells Fargo, alleging the bank intentionally sold high-interest mortgages more to blacks than to whites in violation of federal law.

Nobody here wants the lowly American dollar anymore. Not businessmen, not bankers, not even the "yellow bulls" like this man, who has been a black-market trader for years and whose presence in the lobby of a large state-owned bank is tolerated, oddly, by its managers.As the government has allowed the value of the Chinese yuan to rise faster against the greenback in recent months than it had before, there's been a mad dash by many more people to sell their holdings. Money-changers are so flooded with dollars that they refuse to take any more. It's too risky, they say, because the American currency's value is slipping every day.

In 2007, the yuan appreciated almost 7% against the dollar, and most observers expect the pace to quicken this year. Since Jan. 1, it's risen a further 2%. The dollar might have fallen even faster had the Chinese government let the yuan float freely instead of controlling the daily exchange rate within a narrow 0.5% band. A dollar currently trades for about 7.16 yuan, down from a high of 8.28 in the last decade.

In recent years, the dollar's slide has been much sharper against other major currencies, including the euro and the British pound, reflecting what many experts believe is the result of the U.S.' borrowing binge over many years. That has left the nation deep in hock to foreigners, of which China is among the biggest creditors.

"It's meaningless to buy U.S. dollars," said another Chinese black-market trader whose turf is in front of the Citibank branch in Shanghai's riverfront area known as the Bund. The currency has lost its luster, he said. "Even the government doesn't want it."

This is an ugly story of exploitation and deceit. It involves a Dallas-area couple who tried to fend off foreclosure on their home and wound up victims of a scheme that preys on the desperate. Financial calamities tend to attract con men, and the mortgage mess is no different. It's given rise to what U.S. Bankruptcy Judge Stacey Jernigan in Dallas called a "new cottage industry of bottom feeders" in an order she issued late last year. Bankruptcy attorneys in Houston and nationally told me they've seen variations of the scheme rising with the foreclosure rate.

Here's what happened, according to Jernigan's order: Michael and Brenda White of Mesquite filed for Chapter 13 bankruptcy — a reorganization of personal debts — in June 2006. Three years earlier, they'd bought a home with an adjustable-rate mortgage, which they were no longer able to pay. Under court protection, the couple worked out a plan for new payments and to repay what they owed. Within six months, however, the Whites fell behind again and defaulted on the mortgage, which was being administered by HomEq Servicing in Sacramento, Calif. HomEq notified the couple in January 2007 of a foreclosure sale in early February.

"However, some intervening events occurred ... that are disturbing but not unfamiliar to this court," Jernigan wrote. On the day of the Whites' foreclosure sale, HomEq received a notice that the couple had conveyed a 1 percent interest in their home to a woman in California named Chaka Casey, who had then filed for bankruptcy. Casey's bankruptcy put a "stay" on all creditor claims, which included HomEq's foreclosure proceeding against the Whites' property.

Here's the catch: Casey, who filed her bankruptcy without an attorney, swore under oath that she didn't know the Whites and didn't buy an interest in their home. What's more, her list of assets in the bankruptcy case didn't mention it.

HomEq told Jernigan it sees the practice several times a month. Almost always, the bankruptcies are filed without an attorney, a practice known as pro se. The debtors, without an attorney to monitor their case, have no idea that their bankruptcy filing is being used in the foreclosure scheme. In the Whites' case, for example, no interest was actually conveyed to Casey.

To understand how all this happened, we have to back up a couple of months, to the time when the Whites defaulted on their mortgage. As the threat of foreclosure loomed, they were bombarded with offers, costing as much as $2,000, to fend off foreclosure.

13 comments:

A distasteful smell starting to arise from the Northern Rock saga as per the latest posting from the BBC:

Gordon Brown has been accused of failing to answer questions on Northern Rock, including why its most profitable part will not be nationalised.

There is particular concern about the role of Granite - a Jersey-based trust set up by Northern Rock in 1999 to package up and sell on its best mortgages to investors - which owns about half of the bank's assets.

Granite contains about £45bn of Northern Rock's most profitable mortgages but it will not be nationalised - leading opposition MPs to claim taxpayers will be left with the "rubbish" in the bank's mortgage book.

Anonymous (A)From; America's economy risks the mother of all meltdowns

But Japan is a creditor country whose savers have complete confidence in the solvency of their government. The US, however, is a debtor. It must keep the trust of foreigners. Should it fail to do so, the inflationary solution becomes probable. This is quite enough to explain why gold costs $920 an ounce.

So great inflation happens in the US, what is the effect on Canada??Can $ = Mega US $? or does Canada take a big currency hit too, in relation to the Euro, Huan and Yen?

If there is to be a great inflation in the US, and I believe there is eventually, then it will come only after credit deflation has broken the international debt financing model. Any attempt to inflate now would result in the US being caned in the bond market, which would send the cost of borrowing so high that it would crash the economy. This would precipitate deflation as it would cripple the means to earn enough to avoid widespread debt default.

The Fed is caught between a rock and a hard place right now - and facing deflation whichever way they turn. The problem is that liquidity and confidence go hand in hand - once confidence is gone, so is liquidity, no matter what the powers-that-be do. 'Twas ever thus - every credit expansion in history has ended in credit deflation, and this has been the largest expansion ever, by a wide margin.

IMO currency inflation (like Zimbabwe) is quite a way off, as deflation supports depression and depression supports deflation. That positive feedback spiral should take several years to bottom out (at least as long as the last Great Depression I would think). Although once international debt financing is a thing of the past, and each country that is still independent must make do independently, currency inflation seems inevitable.

The conventional wisdom in a lot of these articles is that, if you are thinking of selling your home, you should do it now, cut your price, get the cash and put it somewhere safe for a couple of years and rent.

However isn't it possible that the credit crisis and the inevitable tightened lending standards could raise the cost of mortgages back up to 15% (like the 70s) or even higher?

Conceivably the houses will be cheaper in a couple of years but the cost of borrowing could be much higher, evening everything out. What do you think?

Our Wishbone World“Let’s look at both sides of the great debate. To the left is the socialization of markets, nationalization by governments and hyperinflation. To the right, we have asset class deflation, risk aversion and the unwinding of the debt bubble.”

If you have a decent amount of equity in your home, and you manage to successfully hold on to the money you get from selling it, you probably wouldn't need to borrow to buy another home in a few years time. Real estate has a very long way to go to the downside and owning a home means taking the price risk, whereas renting is paying someone else a fee to take the price risk for you.

My guess is that real estate is going down 90% (I know that sounds extreme, but it would be quite typical for the aftermath of a mania). For most people though, the remaining 10% would probably be less affordable than the present 100%, due to the lack of credit and high real interest rates that are likely to prevail. The people who will be able to afford to buy (and have a considerable amount of choice) are those who preserved capital now.

Renting isn't without it irritations, or risks such as having to find a new place if landlords are foreclosed upon, but the upside of not losing tens or hundreds of thousands of dollars is considerable. Rents will fall in a deflation, and landlords will end up competing for good tenants with the means to pay, so solvent renters should do well.

There are no 'no risk' options for anything in a deflationary collapse, but I'd say your best options are cash under your own control and short term treasuries (3 months or less). Cash is king in a deflation and you would need to preserve a substantial amount of liquidity if you want to do something like buy a property outright at some point in the future.

My personal choice is not to opt to be entirely liquid, as deflation can easily cause enough disruption to wreak havoc with your ability to obtain the necessities of life by fatally compromising the mechanisms for delivering them (our complex life support systems). For this reason, much of my resources has gone into securing the necessities of existence. I already have a debt-free property that I've had for long enough that it wasn't ridiculously over-priced when I bought it, so I don't need to hold on to enough money to buy one. You can achieve this by moving from an expensive area to a cheap one, which is what I did when I moved from Britain to rural Canada.

I'm also concerned about energy supply, so I put in a renewable energy system and built in enough redundancy that the system should be fairly robust. Remember that efficiency and resilience are mutually exclusive goals. A resilient system - one able to address uncertainty with flexibility - must have redundancy, which looks expensive (ie less cost efficient) on the face of it but gives you options you may well need. After all, you don't know what you'll have (electricity, gas, gasoline, diesel, wood etc), so you need to be able to make best use of whatever you end up having. You can't get rid of all dependencies, but you can minimize them and at least shift to being dependent on things which are locally available (like wood in my case).

Water is an important factor presently supplied through a complex system run by soon-to-be-cash-strapped municipalities. The pressure to cut corners could be significant, and that could have health consequences. We have our own well (run by our own power) and septic, which means a measure of independence. We also have water filters (eg British Berkefeld) like the ones aid agencies use in the third world, so we could also drink from the hundred-year-old hand-pumped dug well on our property, or from puddles if push came to shove.

We can cook with electricity, propane (barbecue), butane (coleman stove), wood (1928 wood range indoors or firepit outdoors) or solar (solar oven). We can charge our battery bank with solar power, mains electricity, or generators using gasoline or diesel. The battery bank runs all the essentials in the house, and a few more things can be run directly by the generators. For alternative transport we have mountain bikes and a dog sled team (which we race for fun at the moment).

Although you pay more for setting yourself up now than you would if you stayed liquid and bought things later, you buy yourself time to learn how to do things differently before you need to depend on being able to do so. It depends how much money you have and what your priorities are. I'd say having no debt is the most important thing as that buys you freedom. Next I'd say to keep a liquidity cushion under your own control (for necessities and property taxes at least), and then buy yourself some of the means to supply the necessities for yourself and your family (water filters and solar cookers are cheap for instance).

If you have anything left after doing all that then you could buy precious metals, but those have their own problems, which is why they'd be last on my list.

Stoneleigh: a great plan if you already own enough to be able to set it up. Even in rural Canada, getting the land and renewable energy system, debt-free, must have cost a pretty penny.

If you are not so well off, I question whether debt-free first, then liquidity, then necessities is the right order. It sure seems like in that case you should prefer necessities, then a liquidity cushion (to hedge risk), then buying off debt (for freedom). You can always sneak away from your creditors with your solar cooker and your water filters, and squat in empty houses, if you find yourself unable to keep making progress on the debts, and let the creditors seize whatever assets you can't take with you. As long as you already have the necessities, and some liquidity, that is. On the other hand you can always keep working on the debts until you can buy your freedom, as long as you can make it another month. That is freedom is more deferrable than liquidity or necessities. Freedom from debt just makes it easier to keep what you already have, but if you don't have much yet, freedom from debt isn't very valuable.

I'm always impressed with your description of your homestead. Your self-reliance reminds me of the Swiss Family Robinson (one of my favorite books when I was young).

Well, this all just got a lot more real, as the buyer for our house just got their house under contract today. So... I have to say goodbye to my self-reliance in Vermont (not nearly as extensive as yours, but quite a bit) and rebuild elsewhere.

I won't go into the details here of why we're leaving, except to say my wife wants a more cosmopolitan existence (we're both city people originally) and I don't want to be stranded on a mountaintop if we do in fact experience a sudden liquid fuel transportation crisis in the next few years. So we're heading to where there is an existing rail network, a major port, rivers, and family. Certainly all important in tough times.

I take your point, but assuming that you'll always be able to walk away from debts is dangerous. Debtors have often faced seriously unpleasant consequences in the past - indentured servitude, debtors' prison, being drummed into the military - and may again. Debts can also be called in, even if you haven't missed payments (this happened to my in-laws in the 1970s in Britain), which would probably mean losing whatever it was you were in debt for anyway (and selling it into a buyers market at a firesale price).

I suppose you must choose what risks you're comfortable with, and that would depend on factors like whether or not you have a family to think of as well. As I said before, there are no 'no risk' options.

I've never actually read the fine print on my mortgage documents. Is this a standard right that banks have, that is, to call in a loan on a whim? Does force majeure have to be declared? Does it matter what kind of mortgage you have or with whom? Are rights different in today's Canada than the 70's Britain? How many questions am I allowed in one post?

Yeah that makes sense. But if you can't provide the necessities for yourself and your family then you have to go into debt, even if that means loading 16 tons, or prison or whatever. And you'll get better terms on the debt now than in the future. Likewise, if you have no liquidity cushion, then the first serious bump in the road will reduce you to needing to go into debt again.

Get what you need to support yourself, and then buy your freedom, even though as you say you may not be able to escape the debts. You can't escape lack of food either.